Reforming Africa’s Fossil Fuel Subsidies

24 April 2018

Despite growing international momentum towards climate change mitigation and the promotion of renewable energy, various African countries continue to subsidise fossil fuels. Why is reforming these policy instruments so important and how should Africa go about it?

 

On the African continent, the low level of electricity access remains a major development constraint and under a business as usual scenario, it is estimated that 89 percent of the world’s energy poor will reside in sub-Saharan Africa in 2030. Although the proportion of energy consumption from fossil fuels remained relatively stable over the past two decades (at nearly 40 percent) in the region, new oil and gas discoveries may spur an increase in the use of fossil fuels for energy production. Rapid population and economic growth will also continue to drive increases in per capita energy demand for both power and transport, the latter being heavily dominated by fossil fuels.[1] As African policymakers strive to meet this growing demand, energy choices made in the coming few years have the potential to lock African countries into high emission trajectories for the next few decades.[2]

Internationally, parties to the Paris Agreement agreed to limit the increase in global average temperature to well below 2°C and pursue efforts towards a more ambitious target of 1.5°C. To meet this commitment, at least three-quarters of existing proven reserves of oil, gas, and coal will need to be left in the ground, according to the Intergovernmental Panel on Climate Change (IPCC). In this context, phasing out subsidies to fossil fuels is vital to achieve the aims of the Paris Agreement. And whilst cost effectiveness is central to influencing energy decision-making in Africa, metrics on the cost of energy unfortunately rarely account for taxes and subsidies. This article takes a look at fossil fuel subsidies in sub-Saharan Africa and considers the opportunities and challenges of reforming such subsidies in the region.

Defining fossil fuel subsidies

There is no internationally agreed definition for fossil fuel subsidies, nor consensus on how they should be estimated. Here, we rely on the WTO’s Agreement on Subsidies and Countervailing Measures, which defines a subsidy as any financial contribution by a government, or agent of a government, that is recipient-specific and confers a benefit on its recipients in comparison to other market participants. This includes the direct transfer of funds (e.g. grants, loans and equity infusion), and potential direct transfers of funds or liabilities (e.g. loan guarantees); government revenue that is otherwise due, foregone, or not collected (e.g. fiscal incentives such as tax credits); government provision of goods or services other than general infrastructure, or purchase of goods, below market-value; and, income or price support.

Estimating Africa’s fossil fuel subsidies

In 2015, the amount of fossil fuel subsidies distributed by sub-Saharan African countries was estimated at US$26 billion, a reduction from US$32 billion in 2013 due to reform efforts and the falling price of fossil fuels, and somewhat compensated by rising energy demand (inclusive of pre-tax and post-tax subsidies).[3] The countries that provided fossil fuel subsidies in excess of US$1 billion in 2015 were Angola, Côte d’Ivoire, Mozambique, Nigeria, South Africa, Tanzania, Zambia, and Zimbabwe. When externalities – such as local pollution, impacts on climate change, road accidents, and congestion – are included, the estimated costs associated with fossil fuel subsidies rise to US$75 billion in 2015 for the whole region. The majority of these costs is related to the consumption and production of petroleum, coal, and electricity.

There is high variation in the provision of fossil fuel subsidies between countries, and reliable country-level data is rather scarce. Databases that do provide country-level data for sub-Saharan African countries include the OECD’s bottom-up inventory of production and consumption subsidies, and the International Energy Agency (IEA)’s estimates of consumption subsidies (adopting a price-gap approach).

The OECD finds that in South Africa, subsidies reached US$3.5 billion in 2016, from US$2.9 billion in 2014. This dataset, however, does not cover other African countries. The IEA estimates South Africa’s fossil fuel consumption subsidies alone at US$3.6 billion in 2016. In comparison, Gabon provided an estimated US$118.7 million in consumption subsidies to fossil fuels in 2016, compared with US$30.9 million in Ghana and US$2.5 billion in the larger economy of Nigeria. In North Africa, consumption subsidies in Libya and Egypt reached US$2.5 billion and US$11.1 billion, respectively. Gabon, for its part, is a significant provider of subsidies per capita, despite a relatively modest amount of subsidies in absolute terms (Figure 1).
 

Figure 1: Normalised fossil fuel subsidies for select sub-Saharan African countries (2016, US$ per capita)

 

Source: IEA fossil fuel database; and World Development Indicators
 

Fossil fuel production in Africa is currently being financed by both governments and public finance institutions. For example, fossil fuel investments made by multilateral development banks in Africa between 2008 and 2014 reached US$13 billion.[4] Or, in South Africa, support by OECD export credit agencies for coal mining and coal-fired power generation reached US$4.5 billion.

International commitments

At the international level, African countries have recognised the importance of fossil fuel subsidy reform by undertaking commitments in various fora. The Paris Agreement aims at strengthening the global response to climate change, including by “making finance flows consistent with a pathway towards low greenhouse gas emissions and climate-resilient development.” Under the agreement, several countries have committed to fossil fuel subsidy reform in their respective nationally determined contributions (NDCs), including Egypt, Ethiopia, Ghana, Morocco, Rwanda, and Togo. In late 2015, UN members adopted the UN Sustainable Development Goals (SDGs), and committed under SDG 12 to “ensure sustainable production and consumption patterns,” including by “rationalising” fossil fuel subsidies. As part of the G20, South Africa has reiterated its commitment to phase out inefficient fossil fuel subsidies every year since 2009. Finally, at the WTO, the “Friends of Fossil Fuel Subsidy Reform” have issued a communique calling for accelerated action in the phase out of fossil fuel subsidies also, which has been endorsed by Ethiopia, Gambia, Ghana, Morocco, Mozambique, and Uganda.

Why reform?

As international pledges need to be backed by concrete action, African countries that provide fossil fuel subsidies – and which have all, at least, committed to the SDG 12 – should pursue domestic reform opportunities in a determined manner. There is mounting evidence that the costs of fossil fuel subsidies far outweigh the benefits. From an environmental perspective, fossil fuel subsidies encourage wasteful consumption, depress investment in energy efficiency, and create an uneven playing field for renewables. The IEA has estimated that phasing out such subsidies would generate 12 percent of the required emissions reductions by 2020 under a 2°C pathway, with 15 percent of these savings are made by Africa.

Fossil fuel subsidies are socially regressive. They help to support the perpetuation of inequality by benefitting the rich and failing to meet the needs of the poorest (see Figure 2). Despite this, their removal would disproportionately affect the poorest, which should also be taken into account. Fossil fuels also damage public health. The IMF has estimated, for example, that phasing out fossil fuel subsidies globally would lead to a 63 percent decrease in worldwide deaths from outdoor fossil fuel air pollution.[5]
 

Figure 2: Benefits accrued from fossil fuel subsidies in developing countries

 

Source: Arze del Granado, Coady and Gillingham (2010), in Whitley and van der Burgh (2015)
 

Fossil fuel subsidies are also economically inefficient, as they impose a significant burden on government budgets and decrease the competitiveness of key industries, such as low carbon businesses and the renewables sector. They can also increase the risk of stranded assets by encouraging capital or operational investments in fossil fuels, and act to undermine the effectiveness of carbon price signals in markets.

Despite this, fossil fuel subsidies are still used by various sub-Saharan African countries. This is in part due to the presence of market failures. For example, subsidies to fossil-fuel power are provided to compensate for electricity tariffs which cover only 70 percent of the cost of power production. The persistence of such subsidies is due to a lack of information about both consumer and producer subsidies, a reliance on fossil fuels in energy or national development plans, weak institutions, and political capture.
 

Figure 3: Fossil fuel subsidies by region (2013, as a percent of GDP, and in USD billions)

 

Note: The figure includes externalities, which are not a burden on government budgets.
Key: LAC = Latin America and Caribbean; ED Asia = Emerging and Developing Asia; MENAP = Middle East and North Africa

Source: Coady, Parry, Sears, Shang (2015)[6]


What are the key factors for success?

Whilst sub-Saharan African countries are relatively low providers of fossil fuel subsidies compared with other regions, future population growth coupled with economic growth puts these countries at increasing risk of fossil fuel-related fiscal burdens. Countries should hence seek reform opportunities in the near-term to reduce such risk. Based on the lessons drawn from various reform efforts across sub-Saharan Africa, a number of key principles for effective reform can be identified.[7]

First, energy decisions impact on wider social, economic, and environmental objectives, and as such, they require a whole-of-government, cross-ministerial approach.

Second, research and analysis is needed to better understand the scope and nature of fossil fuel subsidies, their policy objectives, and the potential domestic impacts of reform. For example, some analysis conducted under Nigeria’s 2011 Subsidy Reinvestment and Empowerment (SURE) programme was issued as public statements on the benefits of fuel and electricity reforms, highlighting the total cost of subsidies in the budget, and communicating government plans to re-direct public finance including towards social safety net assistance.

Third, another key element for success lies in communication and consultation with stakeholders. This can include the building of alliances for change (between government officials, industry associations, companies, trade unions, consumers, political activists and civil society organisations), including by engaging with players that can help offset fossil fuel lobbies. For example, the Namibian Government introduced in 1997 a consultative approach for fuel reform, following protests against reform efforts, which have since been maintained. Under Nigeria’s fuel reform programme, the government’s plan to re-allocated public funds to social sectors was met with distrust by many, making reform even more challenging.

Fourth, mobilising upfront resources (pre- and post-reform) is essential.Subsidy reform can provide significant fiscal space, but only following reform, hence governments need to mobilise up-front financing (whether domestic or international) to support the elements needed in a robust reform process.

Fifth, there is a need for strengthening institutions.This can include setting up independent regulatory bodies supporting reform processes (in part to depoliticise the process), improving state enterprise efficiency, and promoting investment in energy production (for quality and access purposes). For example, in Tanzania, a specialised regulatory agency was set up to monitor reform efforts and keep the public informed on energy prices.

Sixth, reform processes should be accompanied by complementary measures (e.g. new, more efficient subsidies). The impact of reform can be significant for some economic sectors or population groups. Complementary measures can help counteract these, from employment insurance for job loss, to social safety nets (e.g. cash transfers) and budget transfers (to e.g. regions or municipalities). For example, successful fuel subsidy reform in Ghana in 2005-2014 allowed the elimination of school fees in state-run schools and increased funding for public transport and health services in poor areas.

Finally, African countries should be particularly careful about the timing and phasing-in of reforms, while also linking fossil fuel reforms to wider energy sector reforms.Fossil fuel subsidy reforms should set ambitious goals, with credible and specific timelines – and time these with economically advantageous periods in business or sectoral cycles. This can increase the likelihood of reforms being maintained. It is also beneficial to target goods primarily consumed by wealthier sectors or households initially, before goods consumed primarily by lower-income households. For example, in 2014, Angola’s government began reforms with a focus on petrol, which is consumed by wealthier households, before reforming subsidies for kerosene, which is primarily consumed by poorer households.

Conclusion

International commitments can help African governments to develop collective momentum and initiate reforms in fossil fuel subsidies. International cooperation is already having a demonstrable positive effect on domestic action, including through technical and financial support by international organisations. As an example, in 2015-2017, the Global Subsidies Initiative supported Egypt and Morocco in their reform efforts.

African governments should use windows of opportunity for fossil fuel subsidy reform, such as dips in international oil prices, and enact reforms in partnership with international actors, from bilateral donors to multilateral development banks. This would increase the financial and technical resources available for reform initiatives, including analysis of impacts and public communications to mitigate political risks. Access to international financing would also make resources available upfront for “complementary measures” aimed at supporting adversely affected households and sectors, such as support for health and educational services, social protection, and economic diversification.

Cooperation with international partners should incorporate earmarking newly available fiscal resources to climate action, alongside fossil fuel subsidy reform. This can include shifting national and international development finance towards climate projects, and technical support to advance renewable energy in national energy and climate plans (e.g. NDCs).

Finally, governments should ensure that development and export financing ceases to support fossil fuel exploration, production, and consumption. This for example includes the need to rule out climate financing to fossil fuel projects such as coal-fired power plants with carbon capture and storage, or construction of super-critical coal-fired power plants.

 

Authors: Leah Worrall, Senior Research Officer, Climate and Energy Programme, Overseas DeveIopment Institute. Shelagh Whitley, Head, Climate and Energy Programme, Overseas Development Institute. Andrew Scott, Senior Research Fellow, Climate and Energy Programme, Overseas Development Institute.


[1] Whitley, Shelagh, and Laurie van der Burg. Fossil Fuel Subsidy Reform in Sub-Saharan Africa: From Rhetoric to Reality. New Climate Economy, 2015.

[2] For example, fossil fuel-fired power plants often last 25 years.

[3] This assumes that in the case of falling international oil prices, governments only partially pass through reductions to retail prices.

[4] Oil Change International. Shift the Subsidies Database.

[5] Parry, Ian, et al. Getting Energy Prices Right: From Principle to Practice. International Monetary Fund, 2014.

[6] Coady, David, et al. How Large Are Global Energy Subsidies? Working paper, International Monetary Fund, 2015.

[7] See Whitley and van der Burgh, Op. cit., on which this section is based.

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